Anchoring Stability to Sustain Higher and Better Growth
IMF News, May 7, 2012
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- Authors: Christine Lagarde Managing Director
- Published: May 7, 2012
Overview
- Speech by Christine Lagarde, Managing Director, International Monetary Fund, University of Zurich, Zurich, May 7, 2012. As prepared for delivery.
- Central question: how to achieve solid, sustained, balanced, and inclusive growth that spreads gains broadly—reconciling stability and growth rather than choosing one over the other.
- Key framing: three focal issues—short-run path to growth, medium-run path to growth, and the fundamental importance of international cooperation.
Global macroeconomic context and key statistics
- Trade accounts for 94 percent of Switzerland’s GDP.
- IMF estimates global growth to be about 3½ percent this year, with advanced economies at 1½ percent (including a mild recession in the euro area).
- The output gap in advanced economies remains close to 4 percent this year on average.
- Emerging markets and developing countries expected growth: 5¾ percent.
- Global unemployment and youth:
- 200 million people worldwide cannot find work.
- 75 million young people are unemployed.
- In countries of southern Europe, one in every five people cannot find work.
- In countries of southern Europe, one in every two young people cannot find work.
- Public debt among advanced economies: ratio of debt to GDP expected to hit 109 percent next year—the largest ratio since World War II.
- Most countries’ fiscal adjustment pace this year: about 1 percent of GDP on average.
- IMF membership: 188 countries.
- IMF resource boost noted: more than $430 billion.
Short-run growth — diagnosis and policy calibration
- Core premise: in the short run demand matters most for growth and jobs; monetary policy has been deployed (very low nominal interest rates) and may need to go further in some cases, but cannot do the job alone.
- Three “brakes” holding back growth:
- The fiscal brake
- Large legacy public debt requires credible medium-term plans to lower debt.
- Adjustment should be gradual and steady for most countries; some under severe market pressure must move faster.
- If growth is worse than expected, countries should stick to announced fiscal measures rather than announced fiscal targets (i.e., avoid fighting cyclical declines in tax revenues or cyclical increases in spending).
- Current pace: most countries moving at about 1 percent of GDP on average.
- The banking brake
- Banks remain over-leveraged and need to shed excess assets preferably by raising capital rather than cutting lending.
- Expectation: large banks based in the European Union to shed as much as $2.6 trillion by the end of next year, or 7 percent of total assets.
- Only a quarter of that reduction is coming from reduced lending.
- Effect on euro-area credit supply is projected at 1.7 percent of credit outstanding over two years.
- When bank health returns, borrowing costs should fall and monetary policy transmission improve.
- The housing brake
- Excess housing stock and household debt (notably in the United States, Ireland, Spain) weigh on recovery.
- Excess stock is working itself out due to little new investment; still need bolder programs to reduce debt burdens, defaults, and foreclosures.
- Some countries (e.g., Iceland) have made progress; others (e.g., the United States) need to do more.
- Synthesis: banking and housing brakes are easing; fiscal brake must be applied in a way that minimizes harm to growth; monetary policy can remain supportive until channels are more effective.
Medium-run growth — supply-side reforms and labor markets
- Principle: demand fuels today’s growth, but supply determines tomorrow’s—product and labor market reforms are essential for sustained productivity and inclusive growth.
- Product market reforms
- Focus on nontraded sectors (distribution, construction, regulated professions) where protection reduces competition and productivity.
- Example: Greek trucking protection led to importing tomatoes from the Netherlands being cheaper than domestic produce; liberalization underway.
- Labor market reforms
- Main priority: address youth unemployment with well-designed policies—job-search assistance, wage subsidies, on-the-job training, apprenticeship programs.
- Dual labor markets (strong protection for insiders, weak for outsiders) trap young and older jobseekers; reforms should balance flexibility with worker rights and income distribution concerns and require stakeholder dialogue.
- Where competitiveness has been lost (e.g., southern Europe), options include boosting productivity or reducing wages; without exchange rate adjustment, wages may need to adjust in some instances.
- Minimum wage comparisons cited:
- Minimum wage in Greece is 50 percent higher than in Portugal.
- Minimum wage in Greece is 17 percent higher than in Spain.
- Minimum wage in Greece is 5-7 times higher than in Romania and Bulgaria.
- Projected gains from reforms
- IMF preliminary analysis for euro-area countries: over five years, large-scale product market, labor and pension reforms could boost GDP by 4½ percent.
- Synchronized reform efforts magnify gains—importance of coordinated action.
Centrality of cooperation — global rebalancing, financial reform, safety nets, and solidarity
- Rebalancing the global economy
- Balanced growth requires surplus countries (e.g., some emerging markets with external surpluses such as China) to shift more toward domestic demand so global surpluses shrink alongside global deficits.
- Advanced economies need to export more; others need enough domestic demand to buy.
- Low-income countries remain vulnerable and need urgent help to implement sound policies and avoid financial ruin.
- Financial sector reform
- Need a financial system that serves societal interests; progress under Basel III is noted.
- Ongoing work on shadow banking is important.
- Implementation of agreed reforms and coordinated regulation and taxation are necessary to avoid arbitrage.
- Switzerland cited as imposing capital requirements above Basel III while maintaining a thriving financial sector.
- Global financial safety net
- Recent European “firewall” efforts commended.
- IMF membership decision to boost resources by more than $430 billion seen as a major step in global solidarity.
- Solidarity within countries
- Social partnership and inclusive policymaking facilitate fair sharing of growth gains and adjustment pains and ensure political buy-in and social cohesion.
Policy recommendations and prescriptions (implicit and explicit)
- Short-run
- Keep monetary policy supportive; consider additional easing in some cases.
- Calibrate fiscal adjustment: adopt credible medium-term debt-reduction plans; apply adjustment gradually and country-specifically; prioritize announced fiscal measures over rigid targets when growth disappoints.
- Strengthen bank balance sheets primarily through capital raising rather than lending retrenchment.
- Implement bolder programs to reduce household debt, defaults, and foreclosures where housing overhang persists.
- Medium-run
- Pursue product-market liberalization in nontraded sectors to raise productivity.
- Reform labor markets to reduce duality and tackle youth unemployment via targeted programs (job-search assistance, wage subsidies, training, apprenticeships).
- Where competitiveness is eroded, combine productivity-raising reforms with wage adjustments where necessary.
- Coordinate reforms across countries to magnify gains.
- International cooperation
- Encourage surplus countries to rebalance toward domestic demand.
- Complete and implement financial sector reforms (Basel III, shadow banking regulation) consistently across jurisdictions.
- Strengthen the global financial safety net and IMF resources to buffer against shocks.
- Protect low-income countries through concerted assistance to prevent economic disaster.
Conclusion
- Strong, sustained, balanced, and inclusive growth is achievable by reconciling stability and growth through calibrated domestic policies and international cooperation.
- The IMF’s role: to stand with its 188 members to seek stability and growth as foundations for a better future.
- Closing thought: “growth and stability are not mutually exclusive—it is not ‘either/ or’—and we can design a path that reconciles them both.”
Source: Christine Lagarde, "Anchoring Stability to Sustain Higher and Better Growth," speech delivered at the University of Zurich, May 7, 2012.